Finances in Chapter 11 -

      During a Chapter 11 case, the most important issues revolve around the use of cash and other assets. If a debtor has secured creditors, for instance, then he will need to come to agreements with them regarding ongoing future payments, as well as the use of rents or other income which are derivedfrom such property. These rents and income are called "cash collateral". It is defined in Section 363 of the Bankruptcy Code as cash, negotiable instruments, documents of title, securities, deposit accounts, or other cash equivalents, whenever acquired, in which the estate and an entity other than the estate have an interest. It includes proceeds, products, offspring, rents, issues and profits of property, and the fees, charges, accounts or payments for the use or occupancy of rooms and other public facilities in hotels, motels, or other lodging properties which are subject to the creditor's lien.

When Can Cash Collateral Be Used?

      A debtor is not permitted to use cash collateral absent consent of the lender and a court order approving same, and is required to sequester it in a separate account. In the usual situation, the debtor's attorney will negotiate with the attorney for the secured creditor, and come up with a stipulation for use of cash collateral. Typically, the debtor will be authorized to use the cash collateral for needed payments, such as maintenance, taxes, insurance, property management, taxes, utilities, etc., and a management fee, with the balance being remitted to the secured creditor.

Can the Order Permit Use of Cash Collateral?

      If the lender will not consent to use of cash collateral, then the debtor needs to seek a court order giving him permission to use it. The debtor will need to show to the court that the interests of the lender are "adequately protected".

      Under Section 361 of the Bankruptcy Code, this "adequate protection" can be provided in several different ways. It can come in the form of periodic cash payments to the lender, especially where there is a decrease in the value of the collateral; replacement or additional liens; or in any other way which provides the creditor with what is known in bankruptcy jargon as "the indubitable equivalent" of the lender's interest in the property.

What Happens if Cash Collateral is Misused?

      If cash collateral is used without consent of the lender or a court order allowing such use, the court will often find it to be grounds for granting relief from stay to the lender, appointing a trustee, or converting the case to Chapter 7. The courts take the use/misuse of cash collateral very seriously, and well they should, since once it's gone, it is not likely to return.

Additional Financing

      Sometimes, a DIP needs additional financing during Chapter 11 to meet ongoing operating expenses. Since he is in bankruptcy, the normal lending channels are not available. Section 364 of the Bankruptcy Code allows a DIP, subject to court approval, to borrow money (obtain credit). The borrowing can be done on an unsecured, secured, or priority basis. There are some niche lenders who specialize in "DIP financing". Under these loan agreements, such a lender can be given a "super-priority" lien on property of the estate, putting it ahead of unsecured creditors and even existing liens. The DIP will need to demonstrate to the court the urgent need of the funding, and that the interests of the existing creditors will continue to be adequately protected.

Written by Henry Rendler